Political Risks May Foil Economic Reform in China

A migrant worker shields her face at a construction site in Shanghai. China’s five-year plans have given local government officials a single goal: Grow.Credit
Aly Song/Reuters

Can China pull it off?

A couple of weeks ago, the International Monetary Fund told the world that China was essentially doing O.K. It is “transitioning to a new normal,” the I.M.F. said in its regular economic assessment, toward “slower but safer and more sustainable growth.” The main risk, it argued, was that the Chinese government’s push for economic reform might prove “insufficient.”

It seems this is a pretty big risk.

Financial markets were shaken by China’s decision to abruptly devalue its currency on Aug. 11, days ahead of the publication of the I.M.F. report.

Nobody believes China’s official statistics anyway. What if the country’s economy is slowing faster than anybody knows? Developing countries — already reeling from the collapse of China’s demand for their raw materials — could feel the screws tighten further. And if China resorted to further devaluations to bolster exports and work itself out of an economic morass, it would undercut growth worldwide.

Photo

Students at the gates of a primary school in Xianghe, in China's Guangxi region. The low quality of rural education suggests China may face an acute shortage of skilled labor.Credit
Johannes Eisele/Agence France-Presse — Getty Images

On Tuesday, after a 22 percent drop in Shanghai’s main stock market over three days, the Chinese government unleashed a new volley of measures to try to stop the slide, including cutting interest rates and reducing the reserve requirement on banks to stimulate lending again. This added to a rash of less orthodox interventions over the last few weeks, from encouraging borrowing to buy stocks to pledging billions to state-controlled banks to lend to favored projects.

The aggressive actions by the Chinese authorities signal their growing concern over the country’s declining stock market and weakening economy. But, these sorts of moves are not quite what the I.M.F. means when it calls on China to transition from a single-minded export machine into a more complex market economy powered by consumers.

And this brings up a deep, lingering mistrust about Chinese economic governance: There is scant evidence from history that an authoritarian, undemocratic regime like China’s could actually pull off the kind of transformation that it is being called on to make.

“On average, autocratic nations grow faster than democratic ones up to around where China is now,” said David Dollar, a former China hand at the World Bank and emissary to China at the Treasury Department who is now at the Brookings Institution. “But successful cases democratize at around this level of income per capita.”

Here’s how that sounds in Beijing: Further economic change will inevitably lead to political instability — not exactly the strongest incentive for government reform.

A totalitarian regime may be good at deploying capital and labor to deliver raw economic growth. Yet autocracies are not good at fostering innovation and creativity, which rarely flourish where there is no freedom of thought or speech. While “make the economy grow and don’t have demonstrations” might have worked in the past, a bureaucratic command and control structure will have a hard time handling the more complex demands of citizens in countries that reach middle-income status.

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“It must rely more on innovation and provide more services to urban migrants,” said Kenneth Lieberthal, an expert on China at the Brookings Institution. “It also has environmental constraints and a demographic profile that is shifting dramatically, with a rising proportion of dependents and a shrinking proportion of workers.”

It’s easy to get things wrong. Spending in rural areas on health and education has been dismal. For all the progress of urban schools, the low quality of rural education suggests China may face an acute shortage of skilled labor as it moves up the development ladder.

China’s succession of five-year plans has given local government officials a single goal: Grow. This set them off on a binge of borrowing to build everything from roads to industrial parks, often generating lucrative kickbacks for local officials and their families.

“Local governments have been very successful at generating investment and growth, contributing to China’s extraordinary growth performance,” Mr. Dollar wrote. “On the other hand, they have not put as much effort into public goods such as environmental protection or social services.”

To understand China’s predicament, Mr. Dollar compared its experience with some of the best known stories of successful economic development of the last half-century: Japan, which reached China’s income level per capita in the early 1970s; Taiwan, which passed this threshold in the early 1980s; and South Korea, which hit it around 1990.

What is most striking is not how all three countries followed quite similar paths, but how China’s trajectory has diverged from the others’.

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Construction workers in the Yujiapu financial district, in Tianjin in northern China. The huge project has been described as a "ghost town."Credit
Greg Baker/Agence France-Presse — Getty Images

Household spending was always the main source of demand in all three, declining gradually to about 50 percent of gross domestic product when they were about as rich as China is today. Investment rates, which rose sharply in the early stages of their development, peaked at that time at around 35 percent of G.D.P.

By these metrics, China’s economy is upside down: Consumer spending by households is only 35 percent of the nation’s G.D.P. — one of the lowest levels in the world. Its investment rate — nearly 50 percent of G.D.P. — is extraordinarily high. And the productivity of this investment is dismal.

To a large extent, its authoritarian command and control economic governance is to blame. Limits on legal migration to cities promoted an underclass of illegal urban workers toiling for meager wages, slowing consumer spending and hindering urban development. State-owned monopolies plowed profits back into investment rather than into government spending on social welfare. Near-zero interest rates on deposit accounts provided cheap loans to business but penalized savers.

And this means the Chinese transition will be much more complicated. Unlike Japan, Taiwan and Korea — which went into their transitions with substantial trade deficits, which swung into surplus to pick up the slack when investment rates declined — China has been running a hefty surplus for years. A still-fragile world economy is in no position to absorb even more Chinese imports.

And then there is the democratic deficit. The changes China needs today will require enriching — and empowering — its own citizens. Perhaps that’s why despite repeated pledges from top Chinese authorities to reform and “rebalance” its lopsided economy, not much has happened. As the I.M.F. report noted, in most areas China’s progress “has just succeeded in slowing the pace at which vulnerabilities rise.”

Perhaps that’s why financial markets are spooked. “The Chinese, too, think it is unclear where their economy and society will be 10 years from now,” Mr. Lieberthal said.

A version of this article appears in print on August 26, 2015, on Page B1 of the New York edition with the headline: Political Risks May Foil Economic Reform in China . Order Reprints|Today's Paper|Subscribe